Impact investing refers to investment strategies that seek to not only generate financial returns but also aim to foster socially or environmentally beneficial externalities. The underlying goal is to use capital in a manner that generates a positive social footprint.
How is this any different to philanthropy?
There is often a misunderstanding that impact investing is a subsection of philanthropy, when in fact the term gained popularity (after being officially coined in 2007) after increased criticism of philanthropy. Traditional forms of philanthropy and grants have been characterized as unsustainable and driven by the vested interests of private donors and their ulterior motives; or for only being able to cater to one of two relevant goals: either positive discounted cash flows (ie. financial return) or creating social/environmental value – but not both simultaneously, as these both could allegedly not intersect.
In contrast to this, impact investing aims to utilise the strategies of entrepreneurial finance to equip local businesses and organisations with the resources necessary for achieving both aforementioned goals. The aim is to benefit business, the wider community, and investors by rewarding them for their capital commitment.
Private debt and equity impact investors strongly believe that by investing in companies with both profit and social purpose in mind, investors can achieve more of each than if they had helped companies pursue each goal separately.
Why has impact investing grown in popularity?
Impact investing has been gaining ground since the late 2000s, gaining traction as investors became more acquainted with the 17 United Nations Sustainable Development Goals (SDGs). In 2018, Morgan Stanley reported that 84% of investors are interested in incorporating impact investing as a strategy towards building their portfolios, 78% of whom wish to adhere to the UN SDGs.
As such, impact investing has increasingly become a popular topic, for several reasons.
Investors in many financial markets have begun to gradually demonstrate a desire to ‘align their investments with their values’. While this trait is being exhibited progressively amongst consumers, it is refreshing to see that the investing community has also taken it upon themselves to incorporate their values in their investment decisions. Notable entrepreneurs and businesspeople who have spearheaded the impact investment movement include Bill and Melinda Gates, who have been utilising their foundation to invest upwards of $2 billion into 70 initiatives and businesses that primarily focus on ameliorating healthcare and alleviating poverty; profits from their investments are reinvested into the foundation.
With the public eye becoming more attentive and wary of how businesses operate and impact their communities, more investors want to hold businesses accountable for their indirect impacts on other stakeholders, including the environment. A survey conducted by Mckinsey revealed that 82% of investors agree with the statement that ‘companies should be required by law to issue sustainability reports’.
Moreover, there is a growing consensus nowadays around the notion that businesses should be operating sustainably: improving profitability and creating positive social/environmental impact in the long run. Several industries have started to accommodate this, by introducing eco-friendly and sustainable tactics to help uplift underserved communities. This has naturally given rise to the idea of responsible investing and has only incentivized more businesses to follow suit in order to access these benefactors’ capital.
From a financial standpoint, there is increasing evidence supporting the claim that companies that do their due diligence on material, environmental, social and governance factors tend to outperform companies who do not. Contrary to misconceptions, there does not have to be a tradeoff between financial return and supporting the creation of a positive impact. If anything, firms can outperform if they focus on becoming more green (less waste, reducing long term costs), and providing high-quality diversified workplaces that encourage greater productivity, innovation, and employee retention. In 2019, nine of the biggest ESG funds (Environmental, Social, and Corporate Governance funds: portfolios of equities and/or bonds for which environmental, social and governance factors have been integrated into the investment process) outperformed the S&P 500, according to Bloomberg.
Morgan Stanley’s research over the past decade reports that compared to traditional financial products, ‘sustainable investments have the same return profile, with significantly less volatility (making them more valuable)’. JP Morgan reported that impact investments would ‘offer the potential over 2010-2020 for invested capital of $400 billion – $1 trillion, and profit of $183 – $667 billion’.
Here, we see in action the idea that responsible impact investing can catalyze the generation of financial returns as well as a positive change and that it certainly is no fad – all stakeholders (managers, investors, employees and the external community) can benefit.
How effective are impact investments?
McKinsey conducted research that strives to challenge the conventional opinion that impact investments do not operate on a comparable scale to traditional investments, cannot create attractive returns, carry higher intrinsic risk and are less liquid (more difficult to exit). A modest sample of 50 investors in India was used to finance $5.2 billion of projects that coincided with the purpose of impact investing. The findings were very encouraging – from 2010-18, the investments had been growing at an impressive rate of 14% annually, on average. As impact investments continue to grow, evolve, and become more popular, the rate of returns are expected to increase, not only in India but on a global scale.
Furthermore, in 2017, Impact Investment Exchange Asia (IIX, an award-winning Singapore-based impact investment organisation) developed the first of its Women’s Livelihood Bonds series, a financial product that supports enterprises that create more stable livelihoods for low-income women in South & Southeast Asia. It raised over $8 million, directly helping over 385,000 female entrepreneurs in the region.
By January 2020, IIX raised $12 million through its second Women’s Livelihood Bond, generating sustainable income for an additional 250,000 women in Southeast Asia, leading it to earn the 2019 UN Climate Action Award and the P4G State-of-the-Art Partnership of the Year Award. This bond impressively addressed 12 of the 17 UN SDGs, all while providing investors with a diversification of risk across 3 countries, 2 sectors and several borrowers.
These are just a few of several testimonies of how impact investing does its name justice. With increased consciousness of achieving social and financial gains, it will only be natural for trained, savvy investors – such as Mark Zuckerberg and wife Priscilla Chan, who have invested over $110 million into startups and nonprofits alike – to lead the investment community towards the idea of impact investing, especially given that it does not generally pose a higher risk nor provide a lower return.
Impact investing in a post-COVID-19 world: the new normal
As the world slowly begins to recover from the adversities of the COVID-19 pandemic, we must pay attention to rebuilding damaged communities, as well as repairing shattered global financial markets.
The past few months have highlighted the need for investors to identify the impacts of COVID-19 on their portfolios in order to mitigate the issues it poses: financially, but also with respect to human welfare.
The pandemic has been devastating in humanitarian terms but also in an economic and financial sense. The only way for the investment community to recover from this is to be more conscious in selecting where to put their capital. By incorporating more of an emphasis on impact investing, which considers both financial and non-financial performance indicators (employee health benefits, environmental impact, e.t.c.) investors can finally work towards recuperating lost gains, all while giving rise to the importance of community impact in the process of recovery from the pandemic. As businesses respond to this demand from investors and make operations more sustainable, a virtuous cycle is generated that all but accelerates our return to a more environmentally friendly and socially conscious ‘normal’ as a post-COVID-19 global community.
More specifically, the short to medium term future of impact investing includes the materialisation of a COVID-19 vaccine, continued support of small businesses, and creating a sustainable food supply chain. As the world eagerly awaits the development of a vaccine and crowdfunds to uplift affected local businesses, the financial rigour of impact investing, paired with the consciousness for community welfare, will make a more compelling case for this investment strategy, as people look for sustainable and effective ways to support innovation and entrepreneurship.
Certainly, financial markets as we know them will not be the same post-COVID-19; investors will be and are already becoming more analytical and risk averse than ever, in an attempt to mitigate their losses.
More importantly, there is a visible paradigm shift in terms of redirecting the focus onto organisations, businesses, and industries which care just as much about helping locals pull through the hardships of the global crisis, and operating in accordance with the UN’s SDGs, as they do about making money.